Brookfield (TSX:BN) stock has taken a beating this week. Down 5.81% over the last five trading days, it has underperformed the broader market. U.S. treasury yields are rising, which has investors panicking about interest rate-sensitive companies, like banks and BN-style financial conglomerates.
Naturally, BN is being even harder hit than other financials, as it is among the most leveraged of the bunch. Should interest rates go higher, then BN’s earnings will take a hit. However, the company is still an intriguing value proposition from a long-term perspective and is very much still profitable. For this reason, I continue holding my shares and may buy more if the bearish momentum continues.
Cheap valuation
One of the reasons why I like BN stock right now is because it is cheap. At today’s prices, it trades at
- 18.5 times forward earnings;
- 0.52 times sales;
- 1.27 times book value;
- 0.5 times net asset value; and
- 7.5 times operating cash flow.
This is a cheaper-than-average stock going by most multiples. However, the stock does have a very high GAAP (generally accepted accounting principles) price-to-earnings (P/E) ratio: it trades at 335 times that measure of earnings! However, Brookfield’s earnings are heavily impacted by a number of non-cash factors, including depreciation and fair value changes. A rise in depreciation impacted GAAP earnings last quarter. Distributable earnings remain healthy and are still rising this year.
Good deals coming
Another factor that Brookfield has going for it right now is a number of promising deals that either closed recently or are about to close. It acquired the U.S. insurance company American Equity earlier this year for $4.6 billion. The company is profitable and was bought at a low P/E ratio. Brookfield also bought the shipping company Triton International for $4.7 billion. These transactions will add a lot of earnings power to Brookfield Corp, and their effect will begin to be felt in upcoming earnings releases.
One risk to watch out for
Despite all of the positives about Brookfield stock that I pointed out in this article, the company is undeniably vulnerable to one risk factor: interest rate risk.
Brookfield is highly leveraged, with about six times more debt than equity. All of that debt comes with interest costs, and some of Brookfield’s debt is variable rate.
Last quarter, BN’s interest expenses increased by $1.4 billion year over year. That was partially due to rising rates on variable interest rate debt. Some of it was due to the acquisitions the company closed in the months prior to the release, such as American Equity and Triton. The increase in interest expense from those deals is not as bad as that which came from rising rates on variable-rate debt, because it is associated with higher earning power. However, most of the increased interest expense came from existing variable-rate debt. So, the effects of today’s high-rate environment are being felt by Brookfield.
Still, this investment opportunity is an intriguing one. It’s risky, which is why I only have about 2.5% of my portfolio in it. But it could do good things if management executes intelligently.
